The tulip, a flower native to central Asia, created quite a ruckus upon reaching the shores of Europe in the mid-1500s. When a virus attacks a tulip, the resulting colour patterns can be stunning, but the same virus weakens the tulip and makes reproduction a challenge. These rare tulips have always been quite expensive, even to this day. Many associate tulip mania with these rare, high-priced tulips, but scholars report that this first bubble market, where buyers pay far more than something is physically worth because of the resale value, actually stemmed from the common tulip market.

Tulips were not native to Holland. They were introduced to the country from Turkey. Tulip derives its name from the Turkish word ‘tulbend’ that stands for ‘turban’.

The Tulip Mania (1637) phenomenon occurred during the Golden period of Dutch history (1600-1700). During this epoch, Amsterdam was one of the richest cities in Europe. It was the port of entry to Europe and played a prominent role in international trade.

The story of tulip mania is the first-recorded example that involves many timeless issues like behavioural biases and malfunctioning investment markets. Dutch tulips were the first asset to see prices shoot through the roof, only to crash down before one could take notice.

Dutch trade with foreign lands led to the imports of exotic goods that were never seen before by Europeans. Tulips too were introduced to Europe from Persia (Iran) via Turkey when a Sultan sent bulbs and seeds to Vienna as a royal gift. Shortly after 1554, these seeds were sent to Amsterdam, where their popularity began to rise. The rich people in Amsterdam would send for the bulbs directly to the ports, and would pay the most extravagant prices for them. The tulip bulbs became so popular that it was seen as a sign of bad fortune if one didn’t possess a tulip. Rich folks would flaunt their collection at high-profile parties. Tulips had risen to become a status symbol for the elite.

In the book, ‘Extraordinary Popular Delusions and the Madness of the Crowds’ (originally published in 1841), Charles Mackay wrote:

“One would suppose that there must have been some great virtue in this flower to have made it so valuable in the eyes of so prudent a people as the Dutch; but it has neither the beauty nor the perfume of the rose–hardly the beauty of the “sweet, sweet-pea;” neither is it as enduring as either.”

Often, people tend to get attached to things that give them trouble later. They spend a good amount of money based on no merit. In 1634, the rage among the Dutch to possess tulip bulbs was so great that the ordinary industry of the country was neglected, and the population, even the lowest ranks, embarked on the tulip trade. As the mania increased, prices augmented, until, in the year 1635, many people were known to invest a fortune of 100,000 florins (Dutch currency) to purchase forty tulip roots. Gradually, tulips became so costly that they started selling by weight in perits (less than a grain), very similar to the way gold sells in grams and milligrams.

As the trade volumes increased, the future contracts also evolved. This was a big financial innovation of those times.

It became possible to trade in tulips, without actually owning them. The derivative markets grew rapidly. At the peak of the mania, 90% of trades were happening without actual ownership of tulip stock. Eventually, tulip futures were complemented by tulip options. It was now possible to trade in fractions of a bulb. This helped poorer investors get around the ‘denomination’ problem. A poor investor couldn’t afford a whole bulb but could well afford a fraction of one.

At the peak of tulip mania, a single rare bulb would cost 10 times the average skilled workman’s annual wage! In pursuit of quick bucks from tulips, some investors took out loans and also mortgaged their houses. Some began selling their farmlands and jewellery to invest in tulips.

The price and trading of bulbs was increasing at a dramatic pace. A wealthy merchant could invest 10,000 florins in bulbs and then resell them for 20,000 florins in a matter of a few days. This buying frenzy began to drive the market. Old published literature indicates that many investors of futures contracts never even touched a tulip bulb and some didn’t even know what a bulb was!

Tulip bulbs of different varieties were given prestigious titles like Viceroy and Admiral. There is a story that an ignorant sailor mistook one of these expensive bulbs for a small onion, and ate it with his fish. The furious tulip owner dragged him to court, where he was sentenced for several years.

Realising that the tulip mania was reaching maddening proportions, the Dutch government stepped in to reduce the bubble by starting to regulate tulip sales. Also, because of the high demand for tulips, the flowers were now being planted locally on a large scale in Holland. An increase in supply would put downward pressure on prices even before the harvest. Why? Because the agents figured out that the harvest would exceed the demand. This caused a bit of a scare among the traders. A few worried merchants decided to ‘take profit’ and began to sell their inventory in volumes. A quick correction in prices led to further panic among smaller investors too. This led to profit booking which in no time resulted in a crash.

The tulip price peaked and the bubble began to burst in February 1637. The prices of tulip bulbs fell 90% in just six weeks. The market volumes collapsed as everyone wanted to sell bulbs and no one wanted to buy. Eventually, owners of bulbs in the spring of 1637 couldn’t sell their bulbs at even a fraction of their purchase price. There was mass dishonouring of futures and options contracts. A Washington University case study states that the Dutch courts ruled that a buy-sell contract could be termed as completed even if 3.5% of the agreed price was paid to the seller. This provided only minor relief, and that too to buyers not sellers.

The Dutch tulip mania, which dates back to 400 years ago, is a testimony that humans have always been greedy and carry envy in their blood. The investors had greed to get rich quickly. The rich used to flaunt their tulip bulbs to cause envy among others. Gradually the phenomenon turned into herd mentality and investors stopped asking questions about the rationale behind high tulip prices. The financial innovations took place to facilitate the bigger fool theory. The futures and options were floated for the first time in the open market and were the product of tulip mania.

Excerpts from Book : Say Goodbye to the Herd Mentality, authored by Sameer Rastogi


By Sameer Rastogi

18 years of experience, PG in Finance and has delivered Wealth Management lectures at IIM Lucknow, IBS Gurgaon and IIPM Delhi. Contributed to various newspapers. Strength – Application of Economic fundamentals to Investment

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